A VERY BAD, yet long awaited day for financials!!

The stock market suffered its worst daily drop in almost seven years, as the Leh bankruptcy, MER buyout, AIG woes are sunk in the market. Oil back at 95 levels, dollar gaining against Euro, Federal Reserve widening the range of assets eligible as collateral for loans of Treasuries, ECB and Bank of England providing extra short-term liquidity facilities, China cutting its interest rates to 7.2% from 7.47% (first time in six years) - nothing had any positive effect on the markets. Absence of the news, the market would have lost more than 1000 points, i guess..

Tomorrow would be an interesting day, as FOMC meeting is scheduled. Market has already priced in a (50 bps) interest rate cut.. If Fed decides to keep the rates unchanged, I guess the blood bath will continue through tomw.

I guess my reasoning on Dollar gain was right this time.. Dollar was down when the asian and euro markets were open, and continued its loss into the US market trading session. But into the day, investors must have realized the fact that FED/Treasury has not bailed out or guaranteed either of MER or LEH, and the dollar ended green against euro.

Trading strategy for gold:
Bull case: typically during market turmoil, investors flee to safe investments, like Treasuries, AAA rated debt, GOLD or cash (dollars). Yields of treasuries have already comedown since the beginign of the collapse, AAA rated debt has lost its credibility with MBIA, Ambac, AIG under water, cash - dollar is off its peak, and the gold seems to be the only attractive oppurtunity, trading at about 800 levels, off from the peak of 1000.
Bear Case: Since liquidity is the concern for the financial institutions, they are shoring up the balance sheets with cash, and the highly liquid asset that they can sell to do so is gold. So I guess, the selling spree in gold is going to continue for some time.
Strategy: sit on the side lines buying in gold options as the price falls below 760 range. I should buy more AUY options though..

Leh bankruptcy is no doubt the largest ever bankruptcy, and it would remain so.. ( or may be not.. C or GS might b next in line!! ).. Enron had about 60 Bn of Assets, World Com had about 160Bn pf assets, whilc LEH had about 600 bn of Assets dwarfing both enron and worldcom.. In fine print, Leh also had about equal amount of liabilities.. :)


Acronymns that no longer are HOT!!
SIV: Structured investment vehicle.. A buzz word for off balance sheet financing. When the market for ABS. CDO has dried ou t, the financial institutions were forced to bring the assets onto their balance sheet, making the work outdated..
ARS: Auction Rate Securities, used to be a highly liquid (cash-equivalent) investment). Not sure of the numbers but, since the invention of theis financial instrument till Aug'07 only 7 auctions failed.. From Aug 07 till now, many (about 600) failed, and the auctions are no longer held.. and the acronymn is made obsolete..
CDS: Credit Default Swaps.. like an insurance to the credit. In the current market situation, where cash is scarce, the counter party risk in a CDS is magnified. With AIG on the death bed, the unwinding of CDS seems to be the next big shoe to drop. An interesting trade on CDS from here:
"Many credit derivative transactions don't simply involve two parties but are often times the risk is passed from one party to the next several times. When an event occurs it causes a careful examination of the complicated legal documents which spell out the specifics of solving a default event.

In a legal case from last year, Bear Stearns loaned $10 million to a development in the Philippines which was backed by a Philippines government agency. In order to protect itself from default, Bear Stearns purchased protection from AON for about $425,000. AON was then short exposure to the Philippines government agency, and so then purchased protection from Societe Generale for $328,000. Offsetting the risk gave AON an easy $97,000, right?

Well the project went bust, the developer did not pay and neither did the Philippines government agency. Bear sued AON for $10 million to reclaim their loss under the Credit Default Swap it had purchased from them and AON paid. AON then went and sued SocGen for $10 million asking for a summary judgment claiming that since the one CDS had been resolved it should automatically create a resolution for the second CDS. After several courts opined on the case, AON lost their case, and lost $10 million. The final court ruling was that the language in CDS1 and CDS2 were not identical and that the risk was not purely offset. So instead of making $97,000 they lost $10,000,000. Seems like documentation is a real counter-party risk."


Too bad a day for my personal portfolio, but I hope the yellow metal would be my saviour.